Download this Paper Open PDF in Browser

Trade-Off and Pecking Order Theories of Debt

85 Pages Posted: 22 Feb 2005 Last revised: 11 Dec 2007

Murray Z. Frank

University of Minnesota

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: December 8, 2007

Abstract

Taxes, bankruptcy costs, transactions costs, adverse selection, and agency conflicts have all been advocated as major explanations for the corporate use of debt financing. These ideas have often been synthesized into the trade-off theory and the pecking order theory of leverage. These theories and the related evidence are reviewed in this survey. A number of important empirical stylized facts are identified. To understand the evidence, it is important to recognize the differences among private firms, small public firms and large public firms. Private firms seem to use retained earnings and bank debt heavily. Small public firms make active use of equity financing. Large public firms primarily use retained earnings and corporate bonds. The available evidence can be interpreted in several ways. Direct transaction costs and indirect bankruptcy costs appear to play important roles in a firm's choice of debt. The relative importance of the other factors remains open to debate. No currently available model appears capable of simultaneously accounting for all of the stylized facts.

Keywords: Capital structure, leverage, corporate financing, trade-off theory, pecking-order theory

JEL Classification: G32

Suggested Citation

Frank, Murray Z. and Goyal, Vidhan K., Trade-Off and Pecking Order Theories of Debt (December 8, 2007). Available at SSRN: https://ssrn.com/abstract=670543 or http://dx.doi.org/10.2139/ssrn.670543

Murray Z. Frank (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5678 (Phone)

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
852-2358-7678 (Phone)
852-2358-1749 (Fax)

HOME PAGE: http://www.vidhangoyal.com

Paper statistics

Downloads
16,655
Rank
122
Abstract Views
40,556